GST: Rates & Exemptions!

The GST will replace taxes that earn India Rs 6.97 lakh crores. That’s 6.1% of GDP. And so the panel led by Chief Economic Advisor, Arvind Subramanian, recommends a revenue neutral GST rate of 15-15.5% - that translates into a standard rate of approximately 18%, a lower rate of 12% for certain goods and a demerit rate of 40% for certain luxury goods. Besides rates, the panel makes several important observations on the dual rate structure, on doing away with exemptions and the creation of a common national market that will boost the “Make In India” programme. CNBC TV18’s Menaka Doshi asked two GST experts to identify the highlights of that report. Joining her on the show this week are V Lakshmikumaran, Managing Partner, Lakshmikumaran Sridharan & Harishankar Subramaniam, National Leader- Indirect Tax, EY.

Doshi: I am going to start by asking both of your first to respond to the rates that have been put out by the Arvind Subramanian led panel. I have just detailed them, what do you think Lakshmikumaran of a revenue neutral rate of 15-15.5 percent and a standard rate of approximately 18 percent?

Lakshmikumaran: These numbers are looking very attractive; the standard rate of 18 percent and the merit rate of 12 percent and the revenue neutral rate (RNR) of about 15 percent. However, the assumptions made are that the precious metals would be taxed higher and exemptions for number of products and services will be removed including healthcare and education, these are politically sensitive subjects. On one hand, the government wants to give subsidy to the education sector and also give exemption for the life saving drugs in the case of healthcare. On the other hand, if we are going to charge service tax on a whole, it will be a very big question mark as for they are politically right or wrong.

Similarly, if we look at the precious metals, if they are going to charge very high rate then chances of smuggling and not paying the tax are very high because removal of this metal is always easy and many countries don’t charge high rates on precious metals because it considers as investments rather than as a trading of goods and therefore these questions are very important questions. If these taxes are levied on these items also then or RNR will remain at 15 percent, otherwise it will go on inching up and up in which case 18 percent may not stay at 18 percent, it may go up.

Subramaniam: I completely endorse the revenue neutral rate the CEA’s report has recommended. In the current envisaged base that is the best that you can get as of now. What we need to guard against is that the moment you have a revenue neutral rate of 15 percent and the fact is on the ground this could well be a two rate structure or a three rate structure, the fact is if you want to keep the standard rate at 18 percent and which is what seems to be the political consensus at least at the center, then the challenge is you really can’t keep too many items at a merit rate of 12 percent. The report again points out that it is important that you keep the lower rate pretty close to the RNR rate to avoid the political compulsion of pushing more commodities into the lower rate because the moment you do that then the higher rate will no more remain 18 percent, it could inch up to 20 percent.

Further, I do agree the concerns that Lakshmi has raised, both on healthcare, education and precious metals but somewhere at some stage there has to be a give and take if you want a moderate standard rate and that is the political call that they will have to take.

Doshi: I want from both of you the other highlights that stood out for you in the report. Lakshmikumaran, you pointed out the issue of exemptions, you spoke of education and healthcare. Arvind Subramanian’s committee has said in no uncertain terms that exemptions must go, it is said and I quote, ‘if the GST is to be a success – with an uninterrupted value chain that facilitates compliance and a buoyant source of revenue – these exemptions must be plugged.’

Lakshmikumaran: I very much agree and endorse Subramanian’s report. There are many exemptions which need not exist, they should necessarily go. I am not saying that education or healthcare should not be taxed but it will be very difficult political decision. Coming back to the exemptions, I can think of straightaway textile for example, textiles have been exempt from payment of excise duty for long and textile is one of the most complicated subject matter in taxation especially on indirect taxes.

In the case cotton and other wool, etc natural fibers, the fibers themselves are not taxable whereas with respect to polyester, nylon, polypropylene, etc the basic petrochemical – caprolactam or PTA is already taxed. Since the textile product themselves are exempt it is absolutely getting into the cost. The challenge to the government is going to be to tax the textile sector uniformly in a particular rate whether it is merit rate of 12 percent or standard rate of 18 percent, whatever may be the rate. This sector alone could contribute significant revenue and can also have an impact on this 18 percent.

Doshi: So, you have identified exemptions as the other highlight in the report and under that umbrella of exemptions, you have spoken of education, healthcare, and sectors like textiles which will be impacted by GST. Any other highlight that you want to very quickly bring to the table and bring to our viewers?

Lakshmikumaran: The other one is regarding the metals. The ores for example, they get the exemptions and now it will get taxed. Once it is taxed, then the items will get taxed at the higher stages. However, more important I am worried about coal. Coal is attracting a lower rate of excise duty at this point of time. It will attract higher value added tax (VAT) or higher GST but once it is charged and it is going to be used for the production of generation of electricity and electricity being exempt which is not being taxed as of now, this becomes a cost. If electricity is taxed under GST because they can actually charge GST on electricity separately, then again, the cost to the consumer will go up tremendously. Therefore, coal is one more area where you have to address the whole issue very carefully.

Doshi: Evidently, exemptions is the one area in that report that has stood out for Lakshmikumaran and the impact on various sectors is what he has detailed. What has stood out for you?

Subramaniam: To me what stood out was three or four things. First is that the report really goes into detail about the amount of distortion origin taxes bring in the manufacturing and distribution processes in India whether it is central sales tax (CST) or other origin taxes. What is staggering is that 6-7 states which are the biggest manufacturing states, to name Maharashtra, Gujarat, Andhra Pradesh, Tamil Nadu, 50 percent of those trade between the states are nature of stock transfer.

Doshi: Yes, I read that as well.

Subramaniam: Now, the beauty is, when you have a stock transfer, there is a reversal on input VAT on the inputs on those manufactured products, that is one. Further, you have even some states like Gujarat and Tamil Nadu where even if you sell inter-state, other than the inter-state two percent cost, there is further reversal on the VAT on the input side. So, the distortion is huge and this again is used as an argument for very strongly recommending the fact that we should not continue with this 1 percent additional origin tax which is again a cascading origin tax, because this in the current form will apply on supplies which could mean it could even apply on inter-company stock transfers. So, that is a very strong case that has been made and though this has been a reality for many of us to see those numbers are really staggering.

The second is, the pains with which the Chief Economic Advisor (CEA) has validated or rather analysed the NIPFP report, it is primarily to assuage the entire stakeholders of the empowered committee and that is something which is good because that creates a trust and puts out in the open what is the way at arriving at the current revenue neutral rate which is lower than the RNR of 17-18 percent which even the second NIPFP report has put out. the third is the fact that the CEA very emphatically states that we should not go for a band of rates because the band of rates will again create a problem of no common market and the entire slogan of Make In India, making one India will never become a reality.

The fourth is another bold statement. I would say the report has been both pragmatic and bold. Another bold statement is the entire design of the GST. Again, I allude to what Lakshmikumaran said, keeping electricity duty out people are not realizing what this could create as far as manufacturing competitiveness is concerned. The entire fact of rent seeking, parallel economy, cleaning up the economy, black money and ironically you have both real property and alcohol outside which are probably one of the biggest rent seeking activities in our country. Petroleum, with the fact that petroleum and tobacco are even today, even if they are within the GST, the state and the center has the power to tax them over and above under excise and any other tax, again begs for the fact that this should be within the base because if you really don't even bring it in the constitution like you brought petroleum, the chances of it again happening at least me and Lakshmikumaran won't see another amendment in the next 15 years.